2012 outlook piece
for Seeking Alpha and in the upcoming 2012 Roundtable for Bespoke
Investments, I have some positive things to say about investing in
China. As the chart below shows, investing in China has been rough
for the last few years. Since the 2007 high for the S&P 500,
the Shanghai Composite is down about 60% and the Hang Seng is down
One thing that is true in general terms is that markets can
correct in time not just price. After four years of going down in
fits and spurts, it is possible that the China markets are now
ready to go up. We can explore this a little further in this post
and you can draw your own conclusion, but correcting in time is not
an outlier phenomenon.
(Click on chart to enlarge)
In mid-2007 we sold out of Sinopec (
) and a little over a year later went into China Mobile (
). Sinopec was a great hold, I became wary and moved into a less
volatile name with China Mobile, but that was a mediocre hold at
best and we sold it. After having no China exposure for a while, we
added an underweight by virtue of China's weight in Market Vectors
) and iShares Emerging Market Infrastructure (
)--our China weighting is about 1% by way of these funds.
The negative argument for investing in China surrounds anything
to do with real estate, overcapacity, empty cities, debt loads of
the banks and debt loads of the municipalities which contributes to
questions about whether China will be in for some sort of hard
landing. There are also concerns about demographics. GDP growth has
been 9-10% for a long time and I have seen several different
definitions of what would constitute a hard landing. But many
believe that if there is a hard landing in China, there would be
serious social unrest.
The positive argument centers around urban migration, ascending
middle class (an "American-ish" lifestyle), China playing an ever
increasing role in the world economic order and the country
continually becoming wealthier.
I don't think there has been much change to either side of the
ledger in quite a while. I think the same threats will continue to
threaten for a while longer and the same positives will continue to
be the positives for a while longer. I think the decision about
what to do with China boils down to a combination of how long the
China market has been slogging on and which of the two sides will
win out from here.
As you know, there has been a lot of commentary about how bad
things might get in China because of the various things mentioned
above along with other reasons. The reasons are valid but it is
also true that the market has fallen by 60% in four years. And
while it is of course true that it could fall another 60% from
here, I believe the decline thus far discounts a lot of
China is not facing the systemic threats that the U.S. and
Europe are facing, yet it is down more than these markets. I looked
at Germany, France, Spain, Belgium and Italy (Italy is down about
the same as Shanghai) in this context in the last four years. I
think this is saying that China is overdone, Europe has a lot
farther to fall or both.
If you can buy into the idea that China is not facing systemic
threats, then it is a cyclical event and cyclical events tend not
to last this long. A 60% decline more than prices in a cyclical
recession in my opinion. And if a recession of some sort is what is
coming, then it is plausible that since equities turned down so
long ago, they could turn up before a recovery starts. In this
instance, maybe even before the hard landing. Again, you can agree
About that hard landing: Although merely anecdotal, China is
still doing a lot of buying of resources around the world. The
latest news this week is that Yanzhou Coal (
) is buying Australia's Gloucester Coal ((GCRLF)).
For many years I have been saying I want no part of the banks or
real estate companies, and for that matter I don't want to own
companies that rely on discretionary purchases of Chinese trade
partners. I'm not changing my opinion on that, so this rules out
many of the ETFs that exist for investing in China.
For me the story has not changed, it has simply evolved. I don't
like the banks and RE companies and haven't for a long time, that
has not changed. But in terms of what appears to be going on with
lending and overcapacity, the story continues to play out. Likewise
demand for energy, resources (although resources are in part tied
to the overcapacity) and something close to the American lifestyle
continues to increase. This demand creates a tailwind that, as I
often say, has not necessarily mattered lately but it is the
starting point for an investment thesis.
I think energy can be owned, but not solar, also industrials and
utilities. For consumer I would avoid exporters and focus on
consumer items made in China for Chinese people. But to be clear, I
favor the other sectors mentioned. I will be looking to add a
little more Chinese exposure, probably with one stock at 2-3% which
obviously would take the total exposure to 3-4%.
One point of clarification is that I am not talking about
reverse mergers or companies that otherwise domicile in China, but
list primarily in the U.S.
Obviously, you may weigh out the positives and negatives and
conclude it is still something to be avoided. But if you have ever
had some interest in China and think that you might in the future,
then you do need keep tabs on current events and reassess these
various factors every so often. Because if I am wrong about China
in the near term, then it will be a buy at some other point.
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